Sabrient - Monthly Analysis of the Market Based on Sabrient Filters

Aftermath of the Storm

For most of February, the January buoyant effect seemed to have deteriorated to very modest price increases for most major indices. Until about February 20, when things began to unravel, index increases for the month had ranged from 1 to 2%, with value holding a slight margin over growth. Then lightning struck on February 27, and the market suffered a significant correction, the worst since the post 9-11 reopening.

In the wake of the storm, the major indexes were down approximately 2% for the month, bracketed by the Dow Jones, which fell almost 3%, and the Russell 2000 and micro-cap stocks in general, which were down about 1%.

The correction was extremely broad with the storm cutting a swath across all stocks. Indeed, the decline was one of the broadest in recent history, broader than the post 9-11 decline although not as deep. All caps and styles did poorly, with the minor exception of mid-cap value, which actually posted an increase of nearly 50 basis points. To be sure, the mid-cap value issues also declined on those two turbulent days, along with everything else, but they were the least harmed by the storm.

Among small-caps and micro-caps, the growth style had the smallest declines, a continuation perhaps of the January effect among those issues. But mid-caps now have the strongest performance over the trailing 12, 6 and 3 months, and based on their performance in February, which seems to have been generated at least in part by a spate of upward earnings revisions, mid-caps seem to be the favorite of this market.

The first few days of March have seen a continuation of the correction, even though valuations remain in the middle of historic ranges and liquidity seems strong. Hence, the correction should run its course soon as the emotionally driven market tries to right itself. Meanwhile, it is increasingly clear that the market is favoring conservatively priced, GARP-like companies whose business model is strong, stable cash flow growth with conservative accounting.

A word of caution: Much of the damage has been done due to credit fears. Indeed, there are pockets of extreme leverage in the credit markets (particularly in the substandard markets). Credit excess plagues not only this country but perhaps to an even greater extent, international markets. These credit concerns should not be taken lightly as they have the potential to create additional shockwaves in the months to come.

David Brown

Next update: Second week in April.